Which of the following could explain why a manager has estimated a positive net present value (NPV) for a project, in the context of consumer surplus and willingness to pay?

• A. The market price is always equal to the marginal cost, leaving no room for profit.
• B. Consumers' willingness to pay for the product exceeds the cost of production, generating consumer surplus.
• C. Consumers' willingness to pay is less than the cost of production, resulting in negative consumer surplus.
• D. The project only covers its fixed costs but not its variable costs.

Answer: (B)

Verified step by step guidance

1. Step 1: Understand the concept of Net Present Value (NPV). NPV measures the difference between the present value of cash inflows and outflows over a project's lifetime. A positive NPV indicates that the project is expected to generate more value than its costs, making it profitable.
2. Step 2: Recall the definition of consumer surplus. Consumer surplus is the difference between what consumers are willing to pay for a good or service and what they actually pay. It represents the extra benefit consumers receive from purchasing at a market price lower than their maximum willingness to pay.
3. Step 3: Connect consumer surplus to willingness to pay and production costs. If consumers' willingness to pay exceeds the cost of production, this means the product provides value beyond its cost, creating consumer surplus and potential profit for the producer.
4. Step 4: Analyze the market price and marginal cost relationship. If the market price equals marginal cost, there is no economic profit, and consumer surplus is zero or minimal. Therefore, a positive NPV would not arise from this scenario.
5. Step 5: Conclude that a positive NPV is consistent with consumers' willingness to pay exceeding production costs, generating consumer surplus. This surplus translates into potential profits, explaining why the manager estimates a positive NPV.